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The Full Court of the Federal Court of Australia in Caason Investments Pty Ltd v Cao [2015] FCAFC 94 has held that it is reasonably arguable that a party can rely on market-based causation in respect of a claim based on s 729 of the Corporations Act 2001 (Cth) (Corporations Act) under which a person who suffers loss or damage can seek compensation in respect of a defective disclosure document.

The concept of market-based causation involves a causal relationship that does not involve reliance by the plaintiff investor on a disclosure document. Generally, the claim is that a misleading statement or omission in a disclosure document causes the market price for the securities to be inflated so that the investor purchases securities at a price which is greater than the investor would otherwise have paid. The investor then suffers loss, including when the release of the omitted information or the correction of the misleading statement causes the market price of the securities to fall. None of these causal links requires the investor to rely on the disclosure document.

The judgment adds to the growing number of recent Australian cases that have found that market-based causation in shareholder class actions is reasonably arguable.

However, as the Court was only required to determine whether the claim of market-based causation is reasonably arguable, the legal issue remains to be finally determined in Australia.

THE FACTS

The substantive proceeding is a representative proceeding brought by the applicants on behalf of themselves and group members who acquired shares in Arasor International Ltd between 11 October 2006 and 12 May 2008.

The application for leave to appeal arose from the refusal of the primary judge to grant leave to amend the statement of claim so as to include pleadings of ‘market-based’ causation, as distinct from ‘reliance-based’ causation, in respect of a claim based on s 729 of the Corporations Act.

The applicants’ market-based causation case argues causation in the specific context of an information effect in an actively traded market. The applicants’ case is that they and the group members, dealing on-market, acted differently, in that they acquired Arasor shares at a price higher than the price that would have prevailed but for the contraventions and/or retained the Arasor shares in the different circumstances of an inflated market. The applicants further contend that a range of persons, being the market, acted differently. Thus, their causation case relies on the market of investors operating efficiently in that there are sufficient participants making decisions which cause the market to reflect information which was or ought to have been represented or disclosed to the market.

As a pleading dispute, consideration needed to be given to whether the applicants’ contentions as to market-based causation are arguable, not a determination as to whether they will be ultimately vindicated as a correct application of principle in the case.

It is widely accepted that leave to amend should be granted unless the proposed amendment is futile, such that the issue sought to be added is unlikely to succeed, the amendment is likely to be struck out or would cause substantial prejudice or injustice to the opposing party in a way that cannot be compensated by costs. Further, where proposed amendments raise contentious legal issues, the amendments “should be allowed unless they are obviously futile in the sense that they disclose no reasonable cause of action”.

The applicants submitted that the central question on appeal was whether as a matter of principle, the primary judge should have rejected the proposed pleading amendments on the basis that reliance is a necessary element of the cause of action under s 729 of the Corporations Act and therefore necessary to be pleaded.

THE DECISION

Did the primary judge reject market based causation for claims under s 729?

There appeared to be considerable uncertainty as to the effect of the primary judge’s reasons.

The majority (Gilmour and Foster JJ) considered that the primary judge concluded that it was reliance on the disclosure document under s 728 that was an essential element in the cause of action pleaded. That is to say, to successfully claim damages under s 729 in respect of a disclosure document contravening s 728, proof of reliance on that document is necessary.

However, Edelman J disagreed, finding that the primary judge’s reasons did not prevent the applicants from bringing a properly pleaded claim based on marked-based causation. For that reason, Edelman J would have dismissed the appeal on the basis that there was no error in the primary judge’s orders or reasons.

Existing authority on market-based causation

Whilst there is no decision of the High Court or any intermediate Court of Appeal on the central legal issue, the concept of market-based causation has not been expressly rejected in any case and in some cases it has been allowed to proceed to trial or implicitly endorsed as arguable: see Camping Warehouse Australia Pty Ltd v Downer EDI Ltd [2014] VSC 357; Bolitho v Banksia Securities Ltd [2014] VSC 8; Earglow Pty Ltd v Newcrest Mining Ltd [2015] FCA 328; ABN AMRO NV v Bathurst Regional Council [2014] FCAFC 65.

Test for causation under s 729

Section 729 provides two tests for causation that must be satisfied before liability can be imposed:

A person must suffer loss or damage “because” an offer of securities under a disclosure document contravenes s 728(1).

The loss or damage must be “caused by”[1] (i) a contravention of s 728(1) (in the case of the conduct of the directors) or (ii) the inclusion of a statement in a disclosure document by a person referred to in the table in s 729(1) (in this case, by the auditors).

There was no substantial submission made about any difference between the two tests for causation arising from the words “because” and “caused by”. It was assumed that the causal test in both was the same. The sole question agitated was whether the causal requirement in s 729(1) included a necessary requirement of reliance by the applicants on a disclosure document.

As the text does not refer to reliance, the majority considered that whilst reliance is a sufficient condition for establishing causation, it is not a necessary one.

Justice Edelman identified four significant reasons why it is at least reasonably arguable that the causal requirement in s 729(1) does not include a requirement of reliance by the applicants on a disclosure document:

Reliance is not a substitute for the essential question of causation. As a matter of ordinary language, there is nothing in the word “because” that requires that the causal relationship between the event (contravention of s 728(1)) and the outcome (suffering loss or damage) can only be proved by reliance by the applicants on a disclosure document.

Section 729(1) permits liability in cases of omissions. But, it is at best a strain of language to speak of “reliance” upon an omission - how can an investor “rely” on “an omission from a disclosure document” and “suffer loss or damage” when the investor is not aware of the omission?

The respondents initially sought to draw a bright line between: (i) market based causation; and (ii) a circumstance described as “reliance based causation”. But there may not be any sharp contrast between these two examples of causation; both types of causation might be indirect.

As a matter of authority, the concept of market-based causation has not been expressly rejected in any case and in some cases it has been allowed to proceed to trial or implicitly endorsed as arguable.

Is there a reliance restriction separate from causation?

Justice Edelman then considered whether there is a ‘reliance restriction’ separate from causation for claims under s 729.

The respondents’ counsel gave an example which might provide support for the imposition of a ‘reliance restriction’ in s 729. The example concerned a circumstance in which an investor knows of an omission in a disclosure document but nevertheless purchases shares at a price which is inflated by the market due to the omission. When the omitted information is disclosed, the market price falls and the investor suffers a loss. It was common ground in the appeal that the investor could not recover the amount by which the market price had been inflated. It was noted that in this example, the requirements for causation are otherwise satisfied and yet recovery might be denied which may mean there may be further restrictions beyond merely causation contained in the words “because” or “liable for loss or damage caused by”. The reason for such a restriction may be that it is outside the scope of liability for compensation if the investor is aware of omitted information at the time of the investment.

His Honour considered the three possibilities in which such a reliance restriction could arise: (i) as an independent matter of construction of the words of s 729(1); (ii) as a matter of implication into s 729(1); or (iii) as a result of the “policy of the statute”. In the absence of full argument on any of these points, Edelman J considered that the applicants have at least reasonable prospects of resisting any of these bases for a reliance restriction.

It is noteworthy that in considering whether a reliance restriction could arise as a matter of construction, Edelman J considered that:

It was reasonably arguable that a circumstance that is within the scope of liability for compensation is where: (i) the investor suffers loss by market-based causation arising from an infringement of s 728(1); but (ii) does not rely on the disclosure document; and (iii) is not aware of the omitted or misleading nature of the information.

Even if reliance is not a necessary element of the cause of action under s 729, proof of actual reliance might have the effect of facilitating the recovery of additional loss that might flow from proving that loss has been caused by an investor’s reliance upon a disclosure document. For instance, it is possible that an investor who succeeds in proving a market-based causation argument might be limited to recovery of that loss which is the difference between the market price of the securities and the “true” or lower value at which they would otherwise have been purchased. In contrast it is also possible that an investor who succeeds in proving that he or she relied upon a disclosure document to purchase securities that he or she would not otherwise have purchased might be able to recover the full amount of the capital investment, and possibly any additional consequential loss.

Policy considerations

The majority noted the judgment in Grant-Taylor v Babcock & Brown Limited (in liq) (2015) 104 ACSR 195 delivered after the decision of the primary judge. There, Perram J, in obiter, said that if it had been necessary to decide whether shareholders could recover when it was alleged they bought shares at an inflated price caused by a listed company’s failure to disclose information to the market, as required by s 674(2), he would likely have accepted that they could. One factor referred to by his Honour as relevant was:

(iv) ... the underlying context of the alleged infringement. Here s 674 requires disclosure of market sensitive information where it would be expected to affect price (and where the listing rules also require disclosure). The provision assumes the existence of a price effect on the market in general.

The majority accepted the applicants’ submission that although the cause of action provided by s 729 does not necessarily apply only in the case of capital raising by listed companies, at least where the company which is raising capital is, or intends to be listed, the policy considerations to which Perram J in Grant-Taylor referred, which supported market-based causation, are equally applicable. The applicants’ further submission, which the majority accepted had force, was that upon proper analysis, considered in context, the disclosure obligations upon a company which is proposing to raise capital and seek to be quoted on the official list of the Australian Stock Exchange are almost exactly the same as the disclosure obligations arising by reason of continuous disclosure for already-listed companies.

The majority also accepted the applicants’ submission that the policy aim of Corporations Act Ch 6D of protecting investors is facilitated in this context, and not undermined, by an approach to causation, which recognises that disclosure of material information is made to a market of potential investors to which the market of potential investors reacts.

WHERE DOES THIS LEAVE US?

The decision is the latest of a growing number of cases to provide positive commentary on the potential application of market-based causation in order to establish loss or damage in shareholder claims.

As the comments were made in the context of a pleading dispute, they are not determinative of the legal issue. However, they do suggest the Court may be open to facilitating shareholder claims by simplifying the requirements for proof of causation of loss/damage.

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